By K Alec Chrystal and Paul Mizen
Consumption and money demand functions have been the object of countless empirical studies over the last half-century or so. These two relationships still provide the core of textbook models of the macroeconomy, at least at the undergraduate level, and are implicit in the foundations of the more sophisticated models used in graduate textbooks. Consumption behaviour continues to be a topic of major interest to policy-makers, not least because it is the largest single component of aggregate demand and so is central to any macroeconomic forecast. Money demand has been of much less concern recently since many monetary authorities have abandoned monetary targets and adopted inflation targets instead, although, for inflation targeting central banks, money is still of interest when it can be used to help forecast inflation. To do this it must contain leading-indicator properties for some component of aggregate demand, hence if ‘money’ is to provide useful information it must be demonstrated that it has linkages with consumption or investment expenditure. For the household sector that is studied in this paper it is consumption that is relevant. Any other variable that helped to forecast consumption would also be useful, and in this paper we incorporate credit as another variable of potential interest. Credit could be more useful than money as a leading indicator of consumption if households borrow extensively to finance their spending. Credit is taken out simultaneously with the decision to spend because interest charges are levied on amounts outstanding, but money can be held for long periods as idle balances and might also be regarded as an important form of saving.